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SJul 5, 2012

Index Funds Best for Do-It-Yourself Investors

Scott Burns

Q. My wife and I have been working with one broker for 30 years. We aren't anywhere near being in the "1 percent." Our portfolio peaked at $460,000 in November 2007. As the market slid the financial advice we got was "The market goes up. The market goes down. You have high-quality funds. Our analysts say you will be fine. You shouldn't try to time the market." (Even though fund managers and brokers do that every day).

Our investments lost 21.5 percent ($97,000). Way too late, I had her put all of the money in CDs, which were still paying 3 to 4 percent. We would have lost more if we had not done that. As our CDs matured we cautiously got back into the market. My wife still refuses to let go of CDs. She figures no growth is better than losing more. I broached the subject of the index funds frequently mentioned in your column. Our broker is staunchly not in favor of selling our American Funds Growth, Bond, and New World holdings to get into the Vanguard index. Can you provide an apples-to-apples comparison of how these four funds have been performing? —D.T., Austin, TX

A. You received sound advice. Don't blame your broker. She is working within the structure and rules of her brokerage firm. Choosing American Funds for a client is one of the best ways a broker can serve her client in the environment of a brokerage firm— she gets a commission (as she must to pay her bills) and you get funds that have expenses that are very low compared to most of the funds sold through brokerage firms. In addition, there have been long periods where American Funds have done very well, including periods where they have done better than index funds.

Index funds like the Vanguard 500 Index are for "do-it-yourself" investors— people who make their own decisions. Some people worry that this takes a lot of time and knowledge but my Couch Potato portfolios have proven that you can manage your own money without any particular knowledge. All you need is the ability to buy a small assortment of index funds in equal amounts and then rebalance back to equal amounts once a year. You can do this with any discount brokerage firm account. Sadly, most of the legacy financial services firms, such as traditional brokerage houses, are still busy suggesting they have a "special sauce" for beating the market.

According to the Morningstar website, American Funds Balanced Fund A shares have been in the top 25 percent, or better, in the last year, 3 years, 5 years and 15 years. Over the last 10 years they dipped below that and were in the top 26 percent. Unfortunately, your particular funds have not done so well and have had periods when their performance was in the bottom 50 percent.

They may not remain there forever, but the possibility is one of the reasons that I have focused on low-cost index funds for many years— if you stick with the major indexes, you'll almost always be in the top 50 percent and you'll often be in the top 25 percent for equity funds. And with bond index funds you'll almost always be in the top 25 percent.

Q. My wife and I are in our seventies. In the next 6 months, we are going to have about $200,000 in CDs mature. The current rate is not acceptable to us. Please offer us some better alternatives with better rates, that are secure. We have been using the returns on these CDs to pay our property taxes. Today the same CDs won’t pay a quarter of our real estate tax. —J.M., by email

A. We'd all like to find the fabled "Lost Mine of the High Yield CDs" but, like the Fountain of Youth, it does not exist. The best you can do is shop for the occasional bank that is offering a yield that is somewhat higher than other banks. Recently, for instance, bankrate.com showed 8 banks that offered 1 year CDs with yields slightly over 1 percent. This is about 3 times as much as the national average rate of 0.33 percent. You could also get about 1.70 percent on a 5-year jumbo CD compared to the national average rate of 1.14 percent.

Filed Under: Income Investing